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Three Reasons Why Dividend-Paying Stocks Are Worth a Closer Look

Fourth Quarter 2020 

If it's steady income you seek, dividends may offer a more reliable alternative to bonds.



There’s something to be said for the reliability and stability of regular dividends—those quarterly payments that allow profitable companies to reward loyal shareholders.

While stock prices can often be volatile, old-school dividend payments can provide a steady stream of income. And, when dividends are re-invested, the potential rewards can be compounded.

But dividend-paying stocks have fallen out of favor in recent years. High-flying growth stocks—think Apple, Amazon and Alphabet—have de-emphasized dividends in favor of capital appreciation. In the 1970s, dividends accounted for 73% of the total returns of the S&P 500 Index.1 In the last 10 years, they accounted for only 17% (see FIGURE 1). Meanwhile, yield-hungry investors increasingly turned to bonds for regular income.

 

Figure 1

Dividends' Contribution to Total Return Varies By Decade

Data Sources: Morningstar and Hartford Funds, 2/20. *Total return for the S&P 500 Index was negative for the 2000s. Dividends provided a 1.8% annualized return over the decade. Past performance does not guarantee future results. The graph shown is for illustrative purposes only.

 

But in today’s world of zero interest rates, dividend-paying stocks may be worth a closer look. Here are three reasons why:

 

Reason 1: Fixed Income? What Income?

Decent interest rates have been hard to find since the onset of the Great Recession, and just as the Federal Reserve (Fed) started normalizing rates, it cut them back to zero in response to COVID-19. As a consequence, bonds, once regarded as reliable sources of income, have struggled to pay investors any kind of meaningful yields of late.

That’s why investors in search of higher returns may want to consider some of today’s more reliable dividend-paying stocks. What’s more, some analysts believe a cyclical value “bounce-back” recovery may be just around the corner, spotlighting a handful of undervalued companies with balance sheets strong enough to survive the pandemic and cash reserves deep enough to allow for healthy shareholder dividends for years to come.

 

Reason 2: Consistency Has Historically Been Rewarded

Recent research shows that companies that offer steady sustainable dividends without going overboard on payouts have provided the best returns over time.

The study, by Wellington Management,2 divided dividend-paying companies into quintiles, then ranked them from highest to lowest level of payouts. The companies that outperformed the S&P 500 Index landed, surprisingly, in the second-highest rather than highest quintile. That’s right: the “high” beat the “highest.”

This counterintuitive result suggests that some companies were making “excessive” dividend payouts and leaving themselves with less money to invest in future growth, while companies with more moderate payouts were re-investing their earnings while still retaining enough flexibility to pay steady dividends for the long term.

 

Reason 3: Dividend Growth—A Sign of Good Management

In another recent study, Ned Davis Research3 looked at dividends from the vantage point of corporate behavior. The study asked: Since 1972, what kind of company had the highest returns and lowest volatility over time: Companies that grew their dividends? Companies that cut or eliminated them? Companies that stood pat? Or companies that didn’t pay anything at all?

The results showed that companies that grew or initiated a dividend experienced the highest returns relative to other stocks—with significantly less volatility.

The study also noted a strong correlation between corporations that consistently grow their dividends and those with strong fundamentals, solid business plans, and a deep commitment to their shareholders.

Bottom line: Although they’ve fallen somewhat out of vogue, dividends can still play an important role in providing income, especially in today’s low interest-rate environment.

 

Next Steps

  1. Download our white paper, The Power of Dividends, and share it with your clients
  2. Email this article or share it on Facebook, LinkedIn, or Twitter

 

Share this insight with your clients to help them understand The Power of Dividends



1 S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks. Indices are unmanaged and not available for direct investment.

2 Wellington Management and Hartford Funds, 2/20. Past performance does not guarantee future results. The second-quintile stocks outperformed the S&P 500 Index eight out of the nine time periods (1929 to 2019), or 77.8% of the time, while first-quintile stocks came in second, beating the Index 66.7% of the time. Third-, fourth-, and fifth-quintile stocks lagged behind the first- and second-quintile dividend payers.

3 Ned Davis Research and Hartford Funds, 2/20. Dividend policies used in the study are for stocks in the S&P 500 Index.

Important Risks: Investing involves risk, including the possible loss of principal. • For dividend-paying stocks, dividends are not guaranteed and may decrease without notice. Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall.

 

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